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TAGS: EFIN ECON PGOV FR
SUBJECT: THE SOCIETE GENERALE DEBACLE: SOME POSSIBLE IMPLICATIONS 
 
 
¶1. (U) The release of Finance Minister Lagarde's report on Societe 
Generale's 4.9 billion euro loss by a "rogue" trader confirms 
details that we have heard from banking contacts and which have now 
been widely and well reported in the financial press.  Insiders 
comment that "rogue traders happen" and compare the case with 
Barings or Sumitomo.  More important, from our perspective, are the 
implications of the SocGen affair for French finance and business 
and its possible political impact.  SocGen is one of only two major 
French true private-sector, publicly-traded international banks and 
it may not remain independent much longer.  There is no question of 
a bank collapse -- SocGen is France's top retail bank and has more 
than adequate capital.  However, its future in corporate and 
investment banking - its real profit center - is in doubt.  The 
specter of this former crown jewel disappearing is a political hot 
potato and brings out the most interventionist instincts from all 
sides of the French political world, not least its President. 
 
French Banking - a short history 
--------------------------------------- 
 
¶2. (U) Large parts of France's banking sector were nationalized at 
the end of the Second World War, followed by further 
nationalizations in 1981.  Francois Mitterrand later reversed his 
own disastrous nationalization policy and began to privatize 
state-owned enterprises.  In 1987, SocGen was the first of several 
major bank privatizations.  It was followed by the listing and sales 
of Credit Commercial de France, Suez and Paribas, with BNP following 
in 1993.  A significant, mostly market-driven consolidation of the 
sector continued throughout the 1990's.  Societe Generale acquired 
Credit du Nord in 1997. Credit Commercial de France bought Societe 
Marseillaise in 1998 and was in turn purchased by HSBC in 2000 in a 
friendly acquisition.  BNP won a tough battle (with Credit Lyonnais) 
to buy Paribas in 1999, giving birth to France's largest bank and a 
major player in global banking. 
 
¶3. (U) In parallel with the consolidation of private sector banking, 
France's two massive mutual banks expanded and reorganized as well, 
moving far beyond their traditional roles of credit unions and farm 
banks.  Among the mutual banks, Credit Agricole acquired Indosuez in 
1996 while Credit Mutuel purchased Credit Industriel et Commercial 
in 1998.  In the savings bank sector, Banques Populaires bought 
stakes in the financial and investment banking entity Natexis 
(product of the 1996-1998 merger of state-owned Credit National and 
Banque Francaise du Commerce Exterieur) in 1998.  Caisse d'Epargne 
acquired Credit Foncier privatized in 1999.  Several years later, 
Banques Populaires and Caisse d'Epargne merged their financial and 
investment banking subsidiaries into their jointly owned Natixis 
subsidiary (independently one of Europe's top 25 banks, by 
capitalization). 
 
¶4. (U)  This period of turmoil and consolidation also saw the rise 
and fall of Credit Lyonnais.  One of France's top banks across the 
board in the late 1980's, Credit Lyonnais was kept out of the 
Mitterrand privatization program.  However, the bank was undone in a 
sordid affair of massive lending to the US film industry and in 
particular for the failed takeover of MGM.  Credit Lyonnais ended up 
owning the movie studio and eventually lost an estimated USD 5 
billion in Hollywood.  It also fell afoul of California insurance 
regulators in its (unrelated) acquisition of Executive Life and 
survived only by dint of a GOF bailout.  The bank was privatized in 
1999 and acquired by the mutual Credit Agricole in 2003 where it was 
later renamed LCL and reduced to a retail bank network. 
 
The Banking Sector v.2008 
--------------------------------- 
 
¶5. (SBU) France's mutual banks today represent just under 30 percent 
of the banking sector (credit establishments) in terms of assets. 
These banks are, in some cases, listed and traded even while a 
controlling stake in the institutions is owned by the institutions 
themselves or, in theory, by their members and depositors.  The 
former president of a major provincial bank which was acquired by 
Credit Mutuel described the mutual banks to us as independent 
fiefdoms with boards chosen by management and minimal accountability 
for performance to depositors, shareholders or the GOF, though they 
are, of course, regulated by the Commission Bancaire.  Investment 
banking subsidiaries of mutual banks are listed companies but, 
again, overwhelmingly in the hands of the mutual banks (69 percent 
for Natixis; 95 percent for Calyon.) 
 
¶6. (SBU) Until last month, BNP-Paribas and Societe Generale were the 
twin world class private sector, publicly traded international banks 
in France.  (Mutual bank Credit Agricole ranks second in Fortune 
Global 500 for banks with a notional market capitalization of USD 77 
billion, but it is largely self-owned and less of a player in 
corporate and investment banking.)  Part of the motivation for GOF's 
aggressive privatization of the banking sector in the late 1980's 
 
PARIS 00000234  002 OF 003 
 
 
was the view that a dynamic financial sector was essential if France 
were to compete successfully with the UK and a newly united Germany. 
 The development of Paris as a financial center became a key 
objective (the crowning moment of which was the 2007 merger of 
Euronext with the New York Stock Exchange.)  While London and 
Frankfurt had significant leads in most areas of international 
finance, the French banks focused heavily from the outset on the 
emerging equities derivative business.  One senior French banker 
asserted that Societe Generale was generally ranked as the top bank 
globally for equities derivatives trading while BNP-Paribas was 
generally among the top five. 
 
So what happened? 
---------------------- 
 
7.(SBU) In short, the scandal appears remarkably similar to other 
"rogue" trader losses in recent years: a trader promoted from the 
ranks of the back office green eyeshades, engaging in what are 
supposed to be high volume low risk arbitrage trades, decides to 
open an uncovered position, which is hidden by exploiting the 
organization's internal control system.  The trader builds an ever 
larger position which eventually is either exposed or collapses. 
The details of the Societe Generale loss have been widely reported 
and are estimated at 6.3 billion euro for 2008, offset by gains of 
1.4 euro as of late December.  One of our senior banking contacts 
previewed many of the details of SocGen's risk management failure 
which have since been confirmed in the Lagarde report and the press. 
  SocGen ran a "permissive" trading operation in which oversight and 
risk management always took a back seat to trading.  The trader in 
question never took vacation, refused to allow other traders to see 
his book, and was allowed to log frequent cancellations of trades 
(bogus hedge trades in this case.)   It also seems clear that the 
bank ignored a series of warnings and red flags raised about the 
trader's activities from the Eurex exchange.  In the week following 
the scandal, another senior French investment banker told us not to 
be hasty in judging SocGen management.  Out of control traders can 
happen anywhere, he said, and result from the trader mentality. He 
cautioned that the damage to the bank could not be estimated until 
the details of the risk management failure were known.  Over the 
last few days, the trader in question and others appear to have 
confirmed that SocGen trading operated with extremely lax oversight. 
 Proprietary trading profits appear to have been the overriding 
objective of the organization 
 
¶8. (SBU) In terms of unwinding the open position, our contacts agree 
that while the market was highly unfavorable, SocGen had no choice 
but to liquidate the position quickly and in secret.  According to 
our banking contacts, the fraud was discovered by the bank on 
Friday, January 18th. The bank had quantified its exposure by Sunday 
and informed Bank of France Governor Christian Noyer and the 
position was unwound over the next three days culminating with an 
announcement to the Bank's board on Wednesday and a public 
announcement the next day.  The Elysee learned of the situation at 
about the same time as the Commission Bancaire and the bank's 
board. 
 
What does it mean? 
----------------------- 
 
9.(SBU) It is unclear at this point whether Societe Generale will 
survive as an independent entity.  Numerous breakup or takeover 
options have been mooted, prompting French officials to warn off 
foreign "predators."  What is clear, is that the corporate and 
investment banking business of Societe Generale have suffered a 
severe and perhaps mortal blow and that the reputation of French 
finance is badly tarnished, especially in equities derivatives, the 
one area in which France has been a global leader.  At the retail 
level our investment banking contact assured us, SocGen is one of 
seven major banking networks in France and its acquisition or merger 
would have little impact.  Retail banking in France is a saturated 
and slim-margin business.   Societe Generale's extensive investments 
in retail networks in central and eastern Europe should remain a 
valuable asset.  At the corporate level, however, Societe Generale's 
disappearance (whether by pulling back from the corporate finance 
business or by merging into another group) could severely impact its 
traditional French corporate investment banking clients, in the 
midst of a global credit crunch and faced with the backdrop of a 
slowing global economy. 
 
10.(SBU) The possibility of a SocGen takeover raises issues of 
French industrial policy beyond such a deal's impact on French 
corporate clients.  Despite the EU Financial Services Directive, 
President Sarkozy and other senior GOF officials have made clear 
their strong opposition to a merger or takeover by a foreign 
"predator."   The GOF has limited de jure means to block such a deal 
but a great deal of de facto power and we consider that the GOF's 
clear and strong interest in keeping SocGen "French" is consistent 
 
PARIS 00000234  003 OF 003 
 
 
with an emerging Sarkozy version of French industrial policy that is 
very much focused on supporting national champions or facilitating 
mergers and partnerships to create champions that are world leaders 
in their sectors.  We plan to further examine how Sarkozy's approach 
differs from previous versions of France Inc. but it appears that 
maintaining adequate corporate banking support in French hands is 
important to this strategy. 
 
¶11. (SBU) Trading scandals can and do occur anywhere and it would be 
wrong to pin blame for the Societe Generale debacle on French 
business practices writ-large.  But as this story unfolds, the 
clubbiness of the upper reaches French business and government and 
the tolerant environment it engenders is likely to come in for 
further examination.  Gerard Rameix,  Secretary General of France's 
market watchdog, the AMF, was subordinate to then Finance Ministry 
Budget Director and current Societe Generale CEO, Daniel Bouton. 
Banque de France Governor Christian Noyer was chief of staff and 
subsequently an assistant secretary-equivalent at the Finance 
Ministry while AMF President Michel Prada was also a former budget 
director.  All are "inspecteurs des finances," the most powerful of 
the French administration's grand corps of graduates from the Ecole 
Nationale d'Adminstration. None of this suggests wrongdoing -- 
Bouton, Noyer, Prada and Rameix are highly competent -- but it adds 
to the perception that the country's homogenous grooming of its 
elite contributes to myopia. 
 
12.(SBU) Despite high-profile business scandals in recent years 
involving members of the corps - Credit Lyonnais and Vivendi come to 
mind - the inspecteurs des finances still dominate senior management 
of France's most established companies.  And President Sarkozy, for 
all of his criticism of the country's traditional elitist governing 
structures, has shown little appetite for shaking up a system that 
produces CEOs attuned to balancing the interests of shareholders 
with those of the state.  The president's public suggestion that 
Bouton resign ("accept his responsibilities") reflected views the 
Elysee had also passed directly to Societe Generale board members. 
But in the longer term we suspect that in sectors considered 
strategic - finance being one - the Sarkozy government is just as 
happy dealing with an old boys (and girls) club that knows how the 
game is played. 
 
Stapleton